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Carbon Arbitration in Korea

Thursday, April 1st, 2010

As carbon becomes synonymous with cash, more and more carbon emissions related projects are launched and announced. As you might expect, disputes over carbon emissions projects are also growing.

Recently, there was a very significant case in Korea. It was the first arbitration case about carbon emissions trade and caught the attention of lawyers and business people alike. As of February 2010, there were no cases in litigation in Korea.

The incident traces back to 2004 when Daegu City, Korea District Heating Corporation and Taegu Energy & Environment Co. decided to work together to reuse methane gas from one of the largest landfills in Korea, in Bangcheon-ri, a small town in Daegu City.

Daegu had been troubled by the smells coming from the Bangcheon-ri landfill. Residents continuously complained about the stink. The city badly needed to make a decision. The methane gas was the key – if the gas was gone, the smell would also be gone. The city searched for a private company that would invest money to build and operate a landfill gas-to-energy plant. The subsidiary of Daesung Group, Taegu Energy & Environment, signed the contract then constructed the plant by September 2006 for a 23 billion won (US $20 million) investment. Daegu City and Taegu Energy & Environment also signed a contract on the supply of landfill methane gas with Korea District Heating Corporation. Since the Bangcheon-ri landfill plant began commercial operations in October 2006, the complaints from residents have completely ended.

The basic mechanism of the project is very simple. The plant captures and refines the methane gas from the landfill. Daegu gets an annual payment for the use of the methane from Taegu Energy & Environment. Then, Taegu Energy & Environment sells the refined gas to Korea District Heating Corporation, which uses the gas as fuel.

This project was successful both economically and environmentally. Capturing and recycling methane gas has multiple benefits. As well as yielding energy and money, it also prevents a malodorous greenhouse gas from being released into the air.

In 2008, Taegu Energy & Environment sold 49 million cubic meters of refined methane gas to Korea District Heating Corporation, as well as generated 28 thousands kilowatts of electricity for a total of 6.3 billion won in annual sales, up from 5.9 billion won in 2007. Daegu City also got paid 512 million won from Taegu Energy & Environment for the use of the methane. Korea District Heating Corporation supplied heating to 10,000 households through methane gas instead of oil. That caused the effect of saving 29,000 tons of fossil fuel.

However, the honeymoon period was over when the plant was registered as a Clean Development Mechanism (CDM) project with the United Nations Framework Convention on Climate Change (UNFCCC) in August 2007. It was the first case in which a Korean local government registered a CDM project. The UNFCCC issued Certified Emission Reductions (CER s) to Daegu City, which assumed about 11.7 billion Korean won net profit for 21 years when it applies the price of the CER s at 11 euro per ton and an exchange rate 1,700 won per 1 euro. The UNFCCC issued 2.2 million tons of CER s and is likely to issue an additional 2.8 million tons of CER s to Daegu City.

Ironically, this big fortune led to disputes among the three parties over the distribution proportion of the CER s. Each party wanted to have a bigger portion of the annual CER s, while Daegu City insisted the majority of the CER s were its own. However, Daegu, which controls the project, confirmed only 1.15 percent for Korea District Heating Corporation and 0.76 percent for Taegu Energy & Environment for the cost of equipment and labor.

Korea district heating corporation insisted on receiving 50 percent of the amount of CER s’ sales while Taegu Energy & Environment was asking for 30 percent of the sales. There was no precedent to use as a guideline to judge the proportion. They tried to figure out what would be the best solution for all parties with less cost and time. They agreed to file for arbitration rather than litigation, which is pricey and can take up to a few years depending on the case.

Arbitration is an alternative way of producing impartial and fair resolutions to business disputes. But unlike litigation, parties select their own place of arbitration, their own adjudicators and even their own arbitration procedure based on their specific needs as long as each party agrees to the procedure. Arbitration is most commonly used for the resolution of commercial disputes, particularly in the context of international commercial transactions.

Each party, Korea District Heating Corporation, Taegu Energy & Environment and Daegu City appointed Kim & Chang, Yulchon and Min & Partners, respectively, as legal representatives. There were four hearings and the arbitration proceedings lasted only four months until February 2010. The Korean Commercial Arbitration Board (KCAB) concluded that Korea District Heating Corporation would receive 10.33 percent of the CER s, Taegu Energy & Environment would get 1.16 percent, and Daegu City 88.51 percent. KCAB appreciated an additional 5 percent as an invisible contribution to Korea District Heating Corporation because it constructed the methane gas boiler and hot water tanks as well as the methane gas recycling plant. Taegu Energy was recognized for its additional investment into the equipment for acquiring the CERs.

Even though the three parties were not fully satisfied with the result, they still agreed to accept the decision. Mr. Seo Jung-kil, an official at the Environment and Greenery Bureau of Daegu City said, “It was the first case over carbon emissions disputes. There were no precedents to consider as a guideline.” He added, “Since it was a joint venture, we wanted to find a reasonable solution that could satisfy all of us. That is why we opted for arbitration.”

The public relations spokesperson for Taegu Energy & Environment said, “As the leader of the landfill gas-toenergy business, we hope to contribute to utilize landfill gas economically and efficiently. Also, we do our best to reduce environmental pollution and to manage and operate an environmentally friendly landfill.”

According to the arbitration decision, Korea District Heating Corporation took 10.33 percent of the annual 400,000 ton of CER s, or about 41,000 tons annually. The corporation expects an annual 550 million won in additional profit, or a total of 11.7 billion won for the 21 years of the project. It also plans to invest the profit into greenhouse gas reduction and renewable energy projects.

Mr. Roh Tae-woo, public relations officer of Korea District Heating Corporation said, “Besides this project, currently we plan to apply to register two more projects as CDM projects. One project is using nematodeinfected pine trees as a fuel for a cogeneration plant, which aims to reduce 25,000 tons of carbon dioxide per year. Another one is an LNG thermal power generation project in Hwaseong City. The corporation will do our best to reduce the greenhouse gases we emit as well as to live up to the Korean government’s low-carbon, green growth policy.”

Mr. Ahn Gun-hyung, an officer of the KCAB, explained, “Following the first case over carbon emissions, other parties have recently sought arbitration. I think disputes between parties over carbon issues will increase as carbon related projects grow.”

Considering the new trend, the Korean Carbon Law Society (KCLS ) was established on Feb. 25, 2010. It was an approach designed to meet the needs for new regulation to cover carbon emissions-related issues. Professor Kim Sung-su of Yonsei University’s school of law was appointed the first chairman of the KCLS . Prof. Kim said at the inaugural meeting, “The conventional laws could not cover the issues of climate change, greenhouse gases and carbon emissions. We need to study laws and regulations for environment, natural resources and energy.”

A detailed legal approach to the current carbon emissions issues was delivered at the meeting. According to the presentation, different methods are used to settle disputes over carbon emissions trading globally. The Emission Reduction Purchase Agreement (ERPA ) of the World Bank, widely used as a model contract for carbon emissions trading, states that disputes should be settled following the rules of English law and UNCITRAL (United Nations Commission on International Trade Law) arbitration rules. If two parties fail to agree to a venue of arbitration, the place should be the United Kingdom under ERPA.

But the CDM ERPA of the International Emissions Trading Association (IETA ) doesn’t specify a governing law, so it is understood the disputing parties can choose the law they wish. It also states the venue of arbitration should be at Permanent Court Arbitration.

The KCAB’s Ahn explained that there are no specific laws or regulations that govern carbon emissions or carbon trading disputes as of yet. He added that as international carbon trade and commerce increases among the nations of the world, it is an inevitable fact that disputes will rise as well. As these transactions grow more complex, it becomes increasingly important to resolve disputes and conflicts as quickly, efficiently and formatively as possible.

“However, litigation can be costly, time-consuming and lead to a permanent breakdown in business relationships. I strongly believe that arbitration can be the best alternative to litigation over carbon trading related issues. Arbitration is the most commonly used form of dispute resolution in business transactions as well,” Ahn said.

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